Earnings season is in full swing, and when it comes to technology companies, all eyes have been on how they are competing in artificial intelligence (AI). Microsoft got it all started earlier this year, turning heads with its multibillion-dollar investment in ChatGPT developer OpenAI. While this could have given the Seattle-based Windows maker a head start when it comes to AI, its leading competitors swiftly followed suit with moves of their own.
E-commerce and cloud computing giant Amazon (NASDAQ: AMZN) just released its third-quarter results, and the report was so good, you might want to read it twice. Even better, CEO Andy Jassy gave investors plenty of reasons to think that the party could just be getting started.
Last June, Amazon completed a 20-for-1 stock split, its first since 1999. Stock splits are a form of financial engineering by which a company effectively lowers its stock price by issuing more shares. By doing so, the market capitalization of the company does not change. For this reason, if you’re a current shareholder, then the overall value of your position stays the same even though you will own more shares post split. One of the reasons a company decides to split its stock is to increase liquidity by allowing a larger cohort of investors to enter a position at a seemingly lower price target.
As of the time of this article, Amazon stock trades at about $143 per share. Despite its impressive inroads in AI and robust financial profile, the stock just doesn’t seem to want to kick into another gear after a 70% run up so far this year. With some on Wall Street saying a new bull market is underway, now could be an incredible opportunity to buy some Amazon shares at dirt cheap levels.
If you’ve read any of my prior articles, then you probably know that I encourage investors to take a thorough look at the entire financial picture. The income statement, balance sheet, and statement of cash flows are all connected in many ways. While revenue is generally one of the first metrics that investors look at, it often only tells a portion of the story. Moreover, looking at net income or non-GAAP measures can frequently mislead an investor about how a business is performing. The metric that I tend to place the most credence on is free cash flow. While it is not perfect, I find that it serves as a far better proxy for how much cash a business is (or is not) generating.
The chart above illustrates Amazon’s free cash flow on a trailing-12-month basis for the last year. Investors can see that for the second half of 2022 and the first quarter of 2023, Amazon consistently experienced cash outflows on a trailing 12-month basis. Like many of its tech sector cohorts, Amazon is not immune to macroeconomic conditions. For instance, the Federal Reserve steadily increased interest rates over the last two years or so in its efforts to combat inflation. Moreover, purchasing activity for both consumers and businesses fluctuated dramatically during this period. Therefore, growth rates in certain areas of Amazon’s business were not as robust when compared to prior-year periods. The combination of less steady revenue growth and a less favorable expense profile due to its fulfillment network unsurprisingly positioned it for a dramatic level of cash burn.
With all of that said, there is one obvious takeaway from the chart above: Amazon appears to have turned over a new leaf. On a trailing-12-month basis, the period that ended June 30 was the first time Amazon had posted positive free cash flow in a year. Even more encouraging, for the 12-month period that ended Sept. 30, Amazon tripled its free cash flow to $21 billion. While this was a major stride in the right direction, investors may be even more excited to learn how and where Amazon is deploying this cash.
Microsoft was the first big tech company to make a splash in AI earlier this year. Its investment in OpenAI could be viewed as savvy, aggressive, or a combination of the two. Alphabet followed with its own investment in a start-up called Anthropic. And the company’s latest report showcased how AI is fueling a return to accelerating growth in its core advertising business as well as helping it gain momentum in the cloud. While many may have been sleeping on Amazon due to the lack of headlines about its AI moves, I’d argue those quieter moves have been well calculated.
Amazon’s multibillion-dollar deal with Anthropic carried a lot of stipulations that could serve as a bellwether for Amazon. Per the agreement, Amazon Web Services (AWS) will serve as the primary cloud provider for Anthropic. Moreover, the start-up will train its future generative AI models on Amazon’s in-house designed Trainium and Inferentia chips.
This is a huge deal because Anthropic now serves as a direct source of lead generation for AWS and its myriad applications. While AWS dominates the cloud computing infrastructure with nearly a one-third share, according to Statista, this is no time for Amazon to get complacent. Microsoft’s Azure cloud software and Alphabet’s Google Cloud Platform are both gaining momentum and adding meaningfully to their market shares.
During the earnings call, Jassy made it clear that he views AWS as entering a new phase of evolution. He said:
And then we have a $92 billion revenue run rate business, where 90% of the global IT spend still resides on premises. If you believe, like we do, that equation is going to flip, there’s a lot more there for us. Then you look at the very substantial, gigantic new generative AI opportunity, which I believe will be tens of billions of dollars of revenue for AWS over the next several years.
Basically, what Jassy is saying here is that AWS has grown to almost a $100 billion run-rate revenue business, and yet an overwhelming amount of organizations’ IT budgets are still not yet dedicated to off-premises technology like the cloud. Furthermore, when you layer the potential of AI applications on top of the cloud, it’s hard to imagine a scenario whereby AWS doesn’t go parabolic.
The chart above illustrates Amazon’s price-to-free cash flow over the last decade. You’ll notice that for 2022 and part of 2023, the line disappears. This is because Amazon was burning cash.
There are a couple of things to take note of. First, Amazon has returned to positive free cash flow for a couple of quarters now. Second, since its return to positive free cash flow, its multiple has actually decreased. Another way of looking at this is that Amazon has demonstrated not only a return to cash inflows, but has shown that it can improve this metric dramatically in short order. And yet, since returning to positive free cash flow, this multiple has hovered around historically low levels. For instance, take a look at the spikes throughout 2018 and 2019. Despite tripling its trailing-12-month free cash flow for the period that ended Sept. 30, the stock looks a bit depressed by this measure.
I can understand that investors don’t want to get ahead of their skis and price the potential of AI into Amazon’s stock just yet. However, just taking in the current quarter at face value, I am a little surprised to see that the stock hasn’t moved much compared to a few months ago. Investor expectations may be dampening the stock price right now. However, as a long-term investor, I’d encourage you to think about the bigger picture. If you believe that Amazon has real potential to disrupt AI, and if you buy into Jassy’s comments about the secular growth of the cloud, Amazon stock just looks too good to pass up right now.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Adam Spatacco has positions in Alphabet, Amazon, and Microsoft. The Motley Fool has positions in and recommends Alphabet, Amazon, and Microsoft. The Motley Fool has a disclosure policy.
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